As the euro zone is mired in an existential crisis, there are growing doubts about the merits of a monetary union in other parts of the world, including the Gulf states. In an increasingly interdependent world economy, the onus is on flexible adjustment to shocks like the global credit crunch. That would seem to scupper plans for a single currency among the members of the Gulf Cooperation Council (GCC), which met in Abu Dhabi over the past two days.
At the same time, the group of 20 leading economies is discussing greater coordination between the world's main currency areas, especially the US dollar and the Chinese yuan, in a bid to reduce the global imbalances that are fuelling credit and other bubbles. Some, like the World Bank president Robert Zoellick, are even calling for an international gold peg to mitigate exchange rate movements and boost global trade. So who's right?
On the face of it, the case against monetary unions and in favour of flexible exchange rates appears to be overwhelming. Instead of fixing currencies, a managed or floating exchange rate system allows a country to adjust to external shocks like a global financial crisis by depreciating its currency and thereby boosting exports.
That seems much more preferable for the Gulf states, compared with a strong dose of fiscal austerity of the sort currently administered to Ireland and Greece. Both are enforcing swingeing cuts to public spending and workers' wages in a desperate attempt to reduce debt and improve competitiveness.
In extreme situations like Dubai's 2009 sovereign debt crisis, flexible exchange rates also give a sovereign country the option of a partial write-off of its debt or even an outright default on its foreign liabilities. When Russia and Argentina followed this course of action in the late 1990s and early 2000s, both economies experienced long periods of strong growth.
However, to call for partially or fully flexible exchange rates across the globe ignores the reality of increasing interdependence, where the size and openness of an economy matter more than having a sovereign currency.
Small and increasingly open economies like those of the Gulf are vulnerable to external shocks such as the rapid inflow or outflow of highly liquid capital. They also suffer from the uncertainty of volatile exchange rates that raises the cost of trade on which the Gulf states so clearly depend.
That is why in the past the Gulf states put in place a system of pegging their currencies to the US dollar. The dollar peg has provided them with an anchor of stability amid global economic turmoil. It saved Dubai from further capital outflows during its sovereign debt crisis last year.
But this system of pegs exposes the Gulf economies to the risk of US inflation and speculative attacks. The Federal Reserve's latest bid to revive the US economy by injecting $600 billion (Dh2.2 trillion) through asset purchases will, over time, probably induce inflation at home and weaken the dollar abroad. While that would promote US exports and reduce America's trade deficit with China, it would also put upward pressure on currency pegs and trigger a wave of speculative attacks on Gulf exchange rates.
Leaving aside the risks of depending on American self-interest, the Gulf peg is already in some trouble. In 2007, Kuwait abandoned pegged exchange rates in favour of a currency basket when "hot money" poured in and destabilised its financial system. This summer, Qatar's central bank slashed interest rates to keep speculative capital at bay.
All this exacerbates divergent trends between the Gulf economies and undermines the feasibility of a monetary union between the members of the GCC.
But if anything, the post-crisis world economy bolsters the case for a single Gulf currency. Increased diversification, especially away from primary commodities towards financial services, will warrant a switch from dollar pegs to flexible exchange rates. As part of the GCC customs union and single market, both expanded trade and economies of scale support a monetary union, just like the euro zone emerged from the common European market. In a globalising world, small open economies simply can't afford separate, sovereign currencies.
Crucially, the Gulf states can avoid the design fault underpinning the current euro zone crisis. First, they would need a credible mechanism to reduce structural differences. Examples include improving labour mobility and agreeing on certain targeted fiscal transfers.
Second, a Gulf monetary union would require permanent financial coordination, especially on debt levels. Here the Gulf states could adapt the US model by issuing national bonds and also joint Gulf bonds underwritten by all members. That would provide some measure of insurance in case of a sovereign debt crisis.
For now, the peg system seems safe. The current US dollar weakness is offset by a declining euro. Commodity prices are expected to remain far below the July 2008 peak when oil traded at over $148 a barrel. Likewise, inflation across the Gulf states has been kept in the low single digits, with Saudi inflation projected to be 5.3 per cent this year and 5.1 per cent in 2011.
But the future shape of global monetary arrangements is likely to be multipolar, with a few major currencies such as the dollar, the yen and the yuan, as well as some trans-regional monetary blocs like the euro zone and an emerging rouble zone.
In such a world, a single Gulf currency would give the region greater leverage. It would also help produce more diversified global trade using different free-floating or managed currencies. That, in turn, would reduce global imbalances and secure the recovery.
Adrian Pabst is a lecturer in politics at the University of Kent, UK, and a visiting professor at the Institut d'Etudes Politiques de Lille (Sciences Po), France